Floor traders are buying everything they can get their hands on, betting on higher milk prices. But caution still needs to be exercised.

Dairy markets have turned bullish and traders are falling over each other trying to purchase futures contracts across the board.

The largest gains have been seen in Class III and Class IV milk futures. Class III futures have far exceeded the movement in the underlying cash markets, but nevertheless, the anticipation is for higher prices. The combination of buying interest and short-covering from previously sold positions has moved futures dramatically.

Take last week, for example. The block cheese price remained steady for the week while the barrel price increased 3.5 cents. This movement along with the weekly NASS average for the week for nonfat dry milk and dry whey equated to a 23-cent increase in Class III price and a 30-cent increase in Class IV. However, the February Class III contract increased 98 cents while the March contract jumped $1.12. Class IV futures were a bit more realistic, with the February contract increasing 20 cents while March increased 60 cents.

Floor traders are buying everything they can get their hands on and are holding a lot of long positions. Their bet is that higher milk prices are coming and are long overdue, based on high feed prices, higher international prices and heavier culling due to high cull cow prices.

Over the past two weeks, the front-month March corn price increased 63.5 cents, soybeans gained 47.25 cents, and soybean meal gained $17.20 per ton. This continues to add some underlying support to higher milk prices. Grain markets will be very volatile as spring planting comes into focus.

December dairy cattle slaughter totaled 265,000 head, an increase of 34,000 from a year earlier and up 24,000 from November. Slaughter has been higher than the previous year for the past four months. However, the final tally for the year shows slaughter 10,000 head lower than 2009.

This all sounds good, but caution still needs to be exercised here. The market certainly is not bearish, but it may not be as bullish as many seem to think it is and by what is being exhibited by the trade. Either the underlying cash will need to increase consistently or the extra premium will need to come out of the market.

December cold storage was somewhat of a surprise as cheese and butter stocks increased. American cheese increased one percent while butter stocks jumped 17%. It was anticipated stocks would decrease due to good holiday demand. Cheese stocks ended 2010 at 1.026 billion lb., up 6% from the previous year. There were only two months this year during which cheese stocks decreased from the previous month. The general pattern is that stocks decline the second half of the year. Butter stocks increased only two months of the year.

Milk production continues show gains with December production up 2.5% from a year earlier. The surprise on the report was the increase in cow numbers of 16,000 head from November. I have already heard dairy farmers talking of increasing cow numbers to take advantage of the higher prices that milk futures are suggesting. Of course, high feed prices will be a problem for profitability, but those who have hedged feed prices or grow their own feed will be in a lot better position.

My recommendation is to hold off on further hedging using fence positions. With the extra premium in the market right now, put options should be established. Options at any strike price at $16.00 or above for 35-45 cents will protect against a turn in the market. The goal is to implement a strategy that will leave the upside open to take advantage of higher prices if they continue.

Upcoming reports:

Commercial disappearance – Jan. 25

Bi-annual cattle inventory report – Jan. 28

Agricultural prices report – Jan. 31

Dairy Products report – Feb. 1

Fonterra auction – Feb. 1

California Class 4a/4b prices – Feb. 1

January federal order class prices – Feb. 4

World Agricultural Supply and Demand report – Feb. 9

California Class I – Feb. 10

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.

The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.

The dairy price outlook for the year has improved significantly over the past few weeks. It is about time, since higher feed prices will have a definite impact on profitability.

The milk price potential for 2011 has improved substantially since Christmas. Dairy futures have shown dramatically higher prices as a result of the strength in underlying cash markets and higher international dairy prices. In the past week, July through October Class III futures contracts exceeded $16.00 for the first time in the life of these contracts.

The futures price increases were fueled mainly by the increases in butter and nonfat dry milk prices on the spot market and a jump in international price in the latest Fonterra auction.

Last week alone, the butter price jumped 43 cents to $2.10. Buyers became aggressive and bid higher in the attempt to get the needed supply. It is questionable whether this price can be sustained as exporters and retailers assess the effect of this price increase on demand. Historically, a price increase of this magnitude over a few days’ period of time results in a quick retracement of some of the gain. Buyers were attempting to build some inventory as churning activity increased through the end of 2010, but have now put that on hold as they decide how to proceed due to the price increase.

Nonfat dry milk prices were not left behind, with Extra Grade increasing 11.5 cents last week to $1.34 and Grade A increasing 6 cents to $1.33. These are the highest prices since May 18, 2010, and gains seemed to be a direct result of the increase in price on the bi-monthly Fonterra auction.

The latest Fonterra auction held on Jan. 4 resulted in increased prices across the board. The Whole Milk Powder price increased 3.8%, Skim Milk Powder increased 10.9% and Anhydrous Milk Fat increased 10.6% to a new record high. Buttermilk Powder increased a whopping 20.6%. Demand is strong and current supply somewhat limited.

The laggard right now is cheese with the price so far showing only a limited increase. Cheese production increased over the holidays allowing more to be available to the market, with sellers not shy about offering it to the spot market. Over the past few weeks a significant amount of cheese has been traded on the spot market. This is interesting, given the fact that sellers many times step back once buyers become more aggressive, but so far they have not.

Some of this may be due to the large cheese inventory and continued strong production so far. Even with significantly higher grain prices and the milk/feed ratio narrowing substantially, USDA is projecting milk production for 2011 at 195.5 billion lbs. or 2.7% above 2010. How this will all play out as the year progresses is anyone’s guess.

Exports will be a big factor this year. The first 10 months of 2010 showed exports of cheese up an average of 62.0% over last year, with butter and butterfat exports up nearly 250.0%. Of course, this is compared to a significant slowdown in 2009, so we cannot expect the same or similar growth in 2011.

In fact, USDA estimates cheese exports this year to be slightly lower than last year, since both the European Union and Oceania are expected to increase cheese production, according to their recently released World Dairy Situation and Outlook report. Butter exports are expected to remain strong, but butterfat exports from the EU are expected to jump 18% as a result of expected production increases.

The dairy price outlook for the year has improved significantly over the past few weeks. It is about time, since higher feed prices will have a definite impact on profitability. The tight milk/feed ratio will keep expansions on hold. Higher Class III futures could potentially keep production strong as farmers push production in order to take advantage of the higher prices, if they materialize. This has been the pattern and not expected to change anytime soon. All in all, milk prices are looking up for the year.

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.

The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.